Economic update: Consumers spend but economy contracts

Similar to our last monthly look at the UK economy, growth is slowing and a faltering international economy and Brexit uncertainties pose risks to the outlook. Importantly for the UK economy consumers have continued to spend, supported by growing wages and a strong labour market.

On the UK political scene, Boris Johnson’s newly formed Government has doubled down on its commitment to leave the EU by 31 October and has made various public service spending pledges. Most recently, the Prime Minister has asked the Queen to suspend (prorogue) Parliament in the second week of September and commence a new session of Parliament with a Queen’s speech on 14 October.

The UK economy shrunk in quarter 2

UK GDP data was weaker than expected in the second quarter of 2019. The economy contracted by 0.2%, compared with the previous quarter.

There are some mitigating factors behind the slow down. Companies have been running down stockpiles they built up in the first quarter of 2019 in the run-up to the original March 29 Brexit deadline.

Car manufacturers also brought forward their annual shutdowns into the second quarter. However, regardless of these Brexit-related factors, growth is slowing. Activity in the services sector – which accounts for around 80% of GDP – slowed to 0.1%. This was the weakest quarterly figure in three years.

Households continue to support growth

Fortunately for the UK economy, consumers continue to spend. Household consumption increased by 0.5% in the second quarter of this year. The spending is supported by a strong labour market where employment is at record highs. Wages are growing strongly – real pay increased by 1.8% in real terms between June 2018 and June 2019.

Central banks cautious about weak global growth

The Bank of England lowered its forecasts for UK economic growth to 1.3% for this year and the next, citing slowing UK growth and global trade tensions. Weak global growth also played a part in the US Federal Reserve’s decision to cut US interest rates for the first time since 2008. The European Central Bank has signalled that it may shortly respond to weak economic data with new stimulus measures.

A new Government gets to work

August was Boris Johnson’s first full month as Prime Minister. Throughout the month his Government emphasised that the UK would leave the EU by 31 October, with or without a deal.

Continuing the theme of public spending, Government departments will be allocated budgets for 2020/21 on 4 September. A multi-year Spending Review had been expected in 2019, but the Chancellor, Sajid Javid announcedthat the longer-term review will now come in 2020. The Chancellor wants a one-year settlement for 2020/21 to “give Government the time and space to focus on delivering Brexit.”

The new Chancellor has inherited a budget deficit that was a little over 1% of GDP in 2018/19, its lowest level since 2001/02. However, the deficit is forecast to increase a little in 2019/20 and tentative data for the first four months of the year point to such an outcome, if not at a little worse. This is before any of the recent public spending announcements above, which will impact on future deficits.

Next month, the Office for National Statistics will change how it accounts for student loans in the deficit. The change – which is being made so that the deficit better reflects the subsidy element of the loans – will add around 0.5% of GDP to the deficit. As we explained back in 2018, nothing is changing to the actual loans, nor will the underlying strength of the public finances change, but the official measure of the deficit will increase.

Parliament returns from recess on 3 September. Even before it returns, tensions have been raised following the Prime Minister’s request that Parliament be prorogued in the second week of September and re-opened with a Queen’s Speech on 14 October. The pound fell following the news.